Is it normal to include an auto loan payoff in the escrow process? Why can’t I just pay it off outside escrow?

I am in the process of getting pre-approved for an FHA loan mortgage and have an auto loan that is preventing that. I have a relative who will be providing the funds, so that part isn’t a problem. The issue is, the mortgage company has only given us two options for payoff of that loan: 1) Fill out a gift letter and put the payoff money into the escrow account, which will then pay off the auto loan at closing OR 2) Fill out a gift letter, get full copies of the bank statement to prove the money is in the account, make a copy of the check (or check #) that is going to the payoff, and then get a receipt from the auto loan company that verifies the check number received on the payoff.

Why can’t we just pay off the loan outside of all the financing? Then we can show the pink slip to verify it’s paid off and move forward. My mortgage person says it’s because they have to establish the paper trail in case of audit and to ward against money laundering. Is this a legitimate demand?

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